Corporate Cash Holdings and Acquisitions

• Author: Yixin Liu,Erik Lie
• Published date: 01 March 2018
• Date: 01 March 2018
• DOI: http://doi.org/10.1111/fima.12185

Corporate Cash Holdings

and Acquisitions

Erik Lie and Yixin Liu∗

We find that acquirers’ announcement returns decline with their cash holdings, but only when

at least part of the payment is in the form of stock. We further find evidence that acquirers that

use stock payment are overvalued, especially when they have excess cash that they could have

used instead. Collectively, our results suggest that investors interpret announcements of stock

acquisitions as a signal that the acquirers’ equity is overvalued and that high cash holdings

intensify this signal. However, our results are inconsistent with the common belief that cash

holdings induce value-destroying acquisitions.

According to Moody’s Investors Services, US nonfinancial companies rated by Moody’s held

$1.68 trillion in cash at the end of 2015, double the $815 billion amount they held in 2007.

Furthermore, Harford, Klasa, and Maxwell (2014) show that average cash holdings for US firms

increased steadily from about 12% in the 1980s to 14% in the 1990s and 18% in the 2000s. The

magnitude of these cash hoards has attracted substantial attention from the media and activist

investors alike.

Numerous studies articulate the concern that cash hoards give managers leeway to invest in

negative net present valueprojects. Most prominently, Jensen (1986) hypothesizes that “managers

of firms with unused borrowing power and large free cash flows are more likely to undertake

low-benefit or even value-destroying mergers” (p. 328). While Jensen (1986) does not expressly

address the level of cash holdings in his paper, it is plausible that the same argument applies to

cash holdings. Harford (1999) argues that excess cash is simply the result of accumulated free

cash flows and predicts that firms with excess cash tend to make value-destroying acquisitions.

Consistent with this view, Harford (1999) finds evidence that firms with excess cash are more

likely to undertake acquisitions and that acquisitions made by these firms are associated with

lower announcement returns.

In this paper, we revisit the evidence on cash and acquisitions for three reasons. First, results

from the sample period estimated in prior papers may no longer be valid.Harford (1999) examines

a sample of 487 acquisitions from 1977 to 1993. Since that period, several factors might have

affected the extent to which firms spend excess cash on value-destroying acquisitions. Forexam-

ple, the substantial accumulation in cash during recent decades along with a surge in merger and

acquisition (M&A) activity that started in the mid-1990s imply an increase in value-destroying

acquisitions. However, the greater scrutiny of cash hoarding and numerous corporate governance

reforms (including the 2002 Sarbanes-Oxley Act, new exchange requirements on corporate board

Weappreciate valuable comments from Raghu Rau (Editor) and an anonymous referee,which helped improve the paper

tremendously.

∗Erik Lie is a Professor of Financein the Henry B. Tippie College of Business at the University of Iowa in Iowa City,IA.

Yixin Liu is an Associate Professor of Financein the Peter T. PaulCollege of Business and Economics at the University

of New Hampshire in Durham, NH.

Financial Management •Spring 2018 •pages 159 – 173